Is Europe Driving the Bond Market?

05/30/2014 12:01 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

This year's rally in the bond market has caught many by surprise but MoneyShow's Jim Jubak thinks he knows the reason behind the sharp rise in bond prices and the drop in yields.

For the week ahead, I think the thing to watch, if you care about stocks, is the bond market. Specifically the bond market rally. We've got a huge rally in the US long-term treasuries, that's the 10 and 30 years, that we've got, this has been a five-month rally, in fact, in the 30-year treasuries, and we're looking at about 3.3% at a yield, that's for 30-year money, ordinarily low, lowest since 2006. In the 10-year, we've moved down to 2.44%, that's the lowest since 2013.

So, the question that's important—if you're looking at stocks and other markets, besides just bonds-is well, why is this happening? That...typically, when the economy is growing, you'd see yields going up, so, if the thought is here that the economy is not going to grow, the US growth is going to be very, very anemic, yields will be coming down, and you might say, "Well, that's what's happening," and especially if we're talking about, say, like the last couple of weeks in May, we're looking at the next revision of first quarter GDP, and it's supposed to turn negative. That's what the economists surveyed by Bloomberg are saying, that it's going to be from a very, very, very slight up tick of 0.1% in the first read, about half a percentage point down, so, you can say, "well, this is what's driving it," but it looks like what's really driving it is Europe.

What we're seeing is anticipation that the European Central Bank-at its first meeting in June, in the first week of June-is going to do something to stimulate the European economy, which would make the Euro weaker, so we're seeing the Euro move down against the dollar. We're seeing bond yields in Europe also move down, just like they are in the US, on assumption, I would think, that the ECB is not really going to do anything that's going to drive up inflation, that, basically, the European Central Bank might stimulate and expand the money supply, but it's really not going to have a whole lot of effect on inflation, and remember, inflation is the big worry in Europe, or the lack of inflation, actually, because inflation is running at an annualized rate of about 0.7%, way below the 2% that the Central Bank would like to see.

To what we're seeing here, I think, is a sense that treasuries-with the Euro falling, with yields in Europe very, very low-are a better bet, and so, you've got money moving into treasuries because it's safe, and it's also paying a little bit more, and the dollar is a little stronger than the Euro, and I think that's what's driving this bond rally, rather than any fear about the US economy, but watch to see what, indeed, we get out of that first revised, if it's much worse than a negative 0.5%, I think you might see stocks start to move down, but right now, sort of unusually, stocks are staying strong, transports are actually moving up and they're a good economic indicator, since they tend to be, you know, it's trucks, and Retirement Reviews, and things like that, they move up with the economy, so all of that's saying the bond rally is not really about a weak economy, but that could change, and that's what we want to look for for the week ahead.

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